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Most people don’t think I.R.S. income taxes can be cancelled or “discharged” in bankruptcy. They are wrong! Even after the changes to the Bankruptcy Code made in 2005, it is possible to have income taxes forgiven by filing a bankruptcy case.

What are the basic rules? It’s a little complicated, but if the taxes are more than 3 years old, and the taxpayer filed the tax returns more than 2 years before filing the bankruptcy, chances are pretty good that the income taxes can be forgiven through a bankruptcy case.

What governs whether taxes are cancelled in bankruptcy?

It’s the 3 yr/2 yr/240 day rule:

1. The due date for the taxes must be more than 3 yrs before filing the bankruptcy. If he filed his 2006 taxes on or before April 15, 2007 without having an extension of time to file, would have to file the bankruptcy after April 15, 2010. If got extension until Oct. 15, would have to wait until after Oct. 15, 2010.

2. Tax return must be filed more than 2 yrs before filing the bankruptcy (he meets this test).

3. Taxes cannot have been “assessed” or determined to be due by the I.R.S., within 240 days (about 8 months) before filing the bankruptcy.

4. There are a couple of other rules, that I presume there is no problem meeting. #4 Taxpayer(s) cannot have filed a false or fraudulent return. If you just got out of federal prison for tax fraud, that tax is not going to be dischargeable in a bankruptcy!

5. #5 Taxpayer(s) cannot have “willfully attempted to evade or defeat the tax.” Same as above, except you were in prison for tax evasion!

Warning! The above is just a short summary of the actual rules. You should hire an attorney experienced in these matters to review your case and the I.R.S. “transcripts of account” to verify that your taxes are dischargeable, BEFORE filing a bankruptcy. Don’t try this at home! Consult me or a bankruptcy attorney in your area to determine if your income tax is dischargeable.

And remember! These rules apply to income tax only! “Payroll taxes” or the “Trust Fund Recovery Penalty,” different terms for money that YOU WITHHELD FROM AN EMPLOYEE’S PAYCHECK, cannot be discharged in bankruptcy.

You can “wait it out” Payroll Taxes by letting the Statute of Limitations run (if a Revenue Officer doesn’t take all your property in the meantime), or you can compromise it through an Offer in Compromise, or you can pay it out through an Installment Agreement or a Chapter 11 or 13 plan, you just cannot outright cancel it. It is the government’s money. I’ll write more about payroll taxes in a future blog.

Any comments? Let me hear from you!